Western International Securities, Inc. agreed to pay a $475,000 fine as part of a settlement with the Financial Industry Regulatory Authority (FINRA).
From January 2016 through June 2020, Western failed to have a supervisory system in place that was reasonably designed to ensure compliance with applicable securities laws and regulations and with FINRA’s rules prohibiting excessive trading; including FINRA Rule 2111.
According to Western’s WSPs for actively traded accounts, supervisors were required to review daily trade stubs and monthly account statements to identify potential excessive trades.
Western’s WSPs and trade-blotter-based surveillance were not reasonably designed to detect excessive trading. The WSPs failed to provide supervisors with guidance on evaluating cost-to-equity ratios, turnover rates, or any other useful indicators of potentially excessive trading. Surveillance based on commercial smears did not reasonably allow supervisors to incorporate such indicators into their review.
In addition, Western’s WSPs did not require supervisors to take reasonable steps to respond to any excessive trading they might detect. For example, the firm’s WSPs did not require supervisors to identify or document the actual justification for recommending trades beyond specified cost-to-equity ratios or turnover rate thresholds, to contact clients by phone or in person to confirm the suitability of even more active trading or to impose any discipline or increased supervision on registered dealers in response to potentially excessive trading. Instead, supervisors only had to notify compliance staff, who in turn had to send activity letters to clients.
Western European compliance staff sent activity letters to customers based on notification by supervisors and also based on their own review of certain exception reports. By early 2019, however, the exception report reviewed by compliance staff for the vast majority of the company’s accounts did not include cost-to-equity ratios, turnover rates or other useful indicators of potentially excessive trading.
When the company created a new exemption report that included cost-to-equity ratios and turnover rates in early 2019, the company did not provide it to regulators. Instead, the company limited use of the new report to compliance staff, who used it primarily for the ministerial task of sending activity letters when transactions exceed certain thresholds. Additionally, although the new exception report used by compliance staff presented the above two indicators on a trailing twelve-month basis, it did not track other red flag trends or patterns, such as, for example, rapidly accelerating transactions.
Initially, Western used so-called “negative consent” activity letters. If customers did not respond to an activity letter regarding transactions on their accounts, then no additional action was taken. Until 2019, Western generally required customers to return a signed “transaction confirmation” in response to an activity letter.
In some cases—for example, if the customer positively objected to the transaction, claimed it was not authorized, or did not return a signed transaction confirmation if requested—the company had to restrict the account. Otherwise, generally no additional actions were taken. Even if the company identified new red flags of potentially excessive trading, it was Western’s practice to send no more than one activity letter every six months.
Western’s activity letters did not provide customers with a notice explaining the company’s concerns about transactions on their account. The letters were not part of a wider system of supervisory procedures reasonably designed to investigate red flags of potentially excessive trading, determine the relevant facts and then take appropriate action.
Under its procedures, the firm could complete its assessments of possible excessive trading based on clients’ responses to these letters without taking additional steps to determine whether clients fully appreciated the trading activity.
As a result, the activity letter process did not provide the firm with a reasonable basis to believe that clients fully understood the risks presented by active trading, that clients had knowingly accepted those risks, and that trading was otherwise appropriate for them, their investment profile.
Western also failed to consistently enforce its business letter procedures. If individual compliance staff failed to send activity letters, monitor deadlines or limit accounts when required, there was no security.
For example, a sample from the first half of 2020 showed that most compliance staff did not always record if and when an activity letter was sent and returned for a flagged account. Also, in many cases the negotiation continued for a period after the alleged limited negotiation, in one case for more than six months.
As a result of all of the above, Western failed to reasonably review transactions that appeared to be potentially excessive in approximately one hundred accounts. During the relevant period, four former Western registered dealers over-traded some of their clients’ accounts.
Therefore, Western violated FINRA Rules 3110 and 2010.
In addition to the $475,000 fine, the company agreed to a reprimand and restitution of $1,057,632.70 plus interest.